Fifth Street Finance, the business development company (BDC) created by near-billionaire Leonard Tannenbaum, has one less fight on its hands.

RiverNorth Capital Management, once Fifth Street's largest outside investor with a near 9% holding, has ended an activist campaign against the embattled BDC and decided to sell its shares to Tannenbaum and Fifth Street's controversial external manager, Fifth Street Asset Management. The deal, struck ahead of an annual shareholder meeting, takes off the table RiverNorth's campaign to have Fifth Street Asset Management replaced as the manger of Fifth Street's BDC assets, a move which threatened the foundation of Tannenbaum's lending empire.

The settlement came as a major surprise to investors and analysts.

Fifth Street Finance shares, owned mostly by dividend-hungry retail investors, tumbled to new record lows below $4.60. Fifth Street Asset Management, 90% owned by Tannenbaum, surged over 100%, cutting into share losses which had taken the stock from an October 2014 IPO price of $17 to as low as $1.31 a week ago. For RiverNorth, the optics of Friday's settlement are negative.

The fund is selling its shares back at a price of $6.25 apiece, an over 30% premium from FSC's closing share price on Thursday. The deal will make RiverNorth whole on the stock it bought when launching the activist campaign this fall, and it also gives the fund a warrant position in FSAM that may yield a payout as high as $5 million.

Cantor Fitzgerald analyst David J. Chiaverini called the deal "old fashioned greenmail." RiverNorth may be receiving a "great deal" for its stock according to Chiaverini, but he notes remaining FSC shareholders will receive no such preferential treatment. He recommends BDC investors look elsewhere, despite FSC's 15% dividend yield and its trading price at less than 60% of book value.

Earlier in February, FORBES published a three-page magazine piece detailing Leonard Tannenbaum's rise at Fifth Street, his ties with Greenlight Capital's David Einhorn, and many of the concerns shareholders including RiverNorth had raised about the company through lawsuits and activist campaigns.

With RiverNorth selling its shares, one major headache for Tannanbaum is conveniently resolved. Perhaps even more surprising than the the alleged greenmail is how Friday's settlement runs almost entirely counter to RiverNorth's previous arguments against Fifth Street.

After all, RiverNorth sought shareholder votes to replace FSAM as the external manager of FSC's assets for what it characterized was a track record of chronic under-performance. And it went a step further, questioning the governance of FSC by arguing the BDC's poor performance expressly benefited Tannenbaum and FSAM.

But Friday's deal may play into Tannenbaum's hands by making it harder for frustrated investors to challenge the BDC's management agreement or its governance. RiverNorth agreed in the settlement to vote its 5.7% activist stake in Fifth Street Senior Floating Rate, another public BDC created by Tannenbaum, on behalf of management, potentially countering a separate activist campaign run by Ironsides Partners. (RiverNorth and Ironsides declined to comment.)

On its way out of FSC, RiverNorth's said it was reassured by the actions the company has taken since the activist campaign was launched in November. “We are encouraged by the steps the Company has taken to improve its fee structure as well as its commitment to execute against its share repurchase program," RiverNorth chief investment officer Patrick Galley said in a press release.

Those claims are dubious judging by RiverNorth's own proxy statements.

Two changes have occurred since the campaign was opened: FSAM dropped dropped its base management fee from 2% to 1.75% in January. On Friday, FSC CEO Todd Owens further said the BDC would act on its existing share repurchase, buying $25 million shares as soon "as soon as practicable" and conducting a total of $50 million in repurchases through 2016.

As of RiverNorth's last proxy filing, made on Feb. 2, it was unhappy with FSAM's fee concession, which it said perpetuated a "misalignment of interests" with the retail investors who own FSC.

"We believe it is clear that the External Manager has benefited from running a larger portfolio, while stockholders have suffered from uneconomic and value destructive growth," RiverNorth said in the filing. "In addition to paying the External Manager high fees for uneconomic growth that has not resulted in stockholder value creation, the incentive fee structure of the Company does not hold the External Manager accountable for credit losses," the fund added.

Subsequently, Fifth Street Finance reported fiscal first quarter earnings on Feb. 9, which reflected a continued sharp decline in net asset values due to rising credit losses. On a conference call with analysts that day, CEO Owens was peppered by analysts on issues such as fee concessions, but indicated there were no looming changes.

"We feel good about the fee structure," said Owens who added, "it really puts us at the median for the industry as a whole." Analysts dispute this notion, citing newer BDCs such as Goldman Sachs's BDC and
Golub that have look-back features on credit losses or NAV they say ensure managers are not incentivized to chase growth that may play to the detriment of shareholders.

The reality is RiverNorth is suspending its activist campaign without gaining the fee concessions it said could protect shareholders from the inequitable long-term performance laid out in proxy materials.

Perhaps RiverNorth can claim some success on the buyback front. A $50 million in stock buyback would amount to a 150% increase in share repurchases in 2016, helpful for investors given the BDC's near 50% discount to its falling NAV. That being said, FSC already had a $100 million buyback in place. Today's settlement simply further commits FSC to taking action.

Analysts took a negative perspective on Friday's settlement. Jonathan Bock, an analyst at
Wells Fargo who's been highly critical of Fifth Street upgraded the BDC's shares on Jan. 15, citing the prospect RiverNorth could either win its campaign or drive meaningful change. On Friday, Bock downgraded FSC shares once more.

"[L]ittle change has occurred, in our view, and the same poorly performing manager remains in place. Overall, we see this as a net negative for shareholders in that while the BDC will be relieved of potential proxy expenses, there are still class action lawsuits and the manager is now more entrenched than ever," Bock said.

Fifth Street does not share this view. It believes the settlement reflects changes that can improve the company's performance for shareholders, and eliminate expenses such as proxy costs.

"We are pleased that this matter has been resolved in a manner that serves the best interests of all FSC stockholders and avoids a costly and time-consuming proxy contest,” CEO Owens said in a Friday statement. "The buyback, coupled with our previously announced reduction in the base management fee, are important steps to enhance value for all stockholders," he added.

Although analysts like Bock see a negative from Tannenbaum and FSAM taking greater control over FSC, both parties reject such assertions. "As a result of the agreement with RiverNorth, FSAM and I as a group will be FSC’s largest shareholder, with approximately 14.6% of FSC common stock, which we believe further solidifies the alignment of interests between FSAM and FSC,” said Tannenbaum, in a press release.

I’m a staff writer at Forbes, where I cover finance and investing. My beat includes hedge funds, private equity, fintech, mutual funds, M&A and banks. I’m a graduate of Middlebury College and the Columbia University Graduate School of Journalism, and I’ve worked at TheS...